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Improve Billing & Collections

Contractors take on tremendous risk when they perform work. However, more contractors go out of business due to poor cash flow than lack of profitability. Why? Is there as much emphasis on billing and collections as there is on daily construction operations?

While management execu­tives typically have a firm grasp on the cycle of cash through their organizations, what does the financial acumen of your remaining staff look like? More importantly, how educated are your PMs, project administrators, and A/R clerks in the art of billing and collec­tions? Are your company’s systems and processes standard­ized in these critical areas?

A contractor’s cash flow is largely driven by one thing: the cash flow of its individual projects. In this article, we will discuss the key indicators that are necessary to give early warning to cash flow issues, the importance of a properly crafted schedule of values, how to implement a structured billing process, and how to define the internal escalation process for collections.

Key Indicators

When a project’s cash flow goes south, it is not usually a surprise. Your team can spot the early warning signs only if it has the right tools and knows how to use them. There should be standard reports both at the corporate and project levels that allow for cash flow visibility. While monitoring cash flow at the corporate level is important, the solutions to cash flow are derived at the project level.

Owners

It is critical to monitor key financial indicators at the cor­porate level so that upper-level managers can detect a cash flow issue early. There are many items to review regularly that can serve as early warning signals.

At the enterprise level, monitoring current ratio and quick ratio give a snapshot in time of the asset to liabilities calcu­lation as a roll-up. Establishing minimums for these ratios and building red flags into your reporting structure is key to identifying issues quickly. Analysis of working capital by dollars, percentage, and yearly turnover are also important indicators of the company’s financial health.

From the owner’s perspective, a roll-up of project overbill­ings and the cash position are also essential to review. Lastly, looking at debt to equity ratios and establishing a maximum threshold for this is also an important data point to monitor. All of these are key indicators that would compel you to dig deeper once a problem was identified. (You can also use such tools as CFMA’s Financial Benchmarker to compare this data. Visit www.financialbenchmarker.com.)

Many companies create a balance sheet and income state­ment either monthly or quarterly. Interestingly, fewer pub­lish a statement of cash flows. Best in Class companies also publish a forward-looking cash projection, which could be crafted as a 12-week look ahead based upon the projects on the WIP and the PMs’ understanding of their project sched­ules and work planned. This cash projection gives the com­pany time to react to an oncoming shortfall more effectively.

(Read more on creating a forward-looking financial forecast in “Turning Numbers Into Insight: Enhance Your Influence & Credibility” by Philip Campbell in the January/February 2015 issue.)

Project Level

There are relevant indicators that can be created at the project management level. Within your company’s job status report; there should be two very clear indicators of cash position of the project: overbillings/underbillings and net cash position. During the monthly project review, these two key data points should be reviewed and expectations for the PMs to uphold should be set.

The PM is the singular point of responsibility over a project. There is a distinct difference between a “Project Witness” and a “Project Manager.” If expectations are clearly set around overbillings, such as a net overbilled position of at least 20%, this can be measured and the PM can be held accountable.

There is a quantifiable data point to measure the PMs’ effectiveness in this area. This measurable can be incentivized, drive the desired positive behavior, and turn those who might be simply witnessing a job’s cash position into those who want to drive it and ensure that they hit their targets.

The very same can be said for the net cash position, which simply states how much has been paid out vs. what has been collected. While this may seem remedial to some, driving this level of knowledge to the project level is key. A true PM wants to manage all of the direct job costs, the billing, and the collections process.

Schedule of Values

Creating a schedule of values includes the mechanics of how the budget cost data is procured and organized, what format to use to ensure that the correct costs fall into the correct categories, a review of the schedule of the project to clarify which activities will occur early in the project, and correct assignment of the general conditions and start-up costs (e.g., mobilization, design, detailing, submittals, material procurement, and prefabrication).

If a schedule of values is done poorly, then maintaining a positive cash position is virtually impossible. A controversial piece to define is whether or not to front-end load the schedule of values and, if so, by how much. This is an enterprise-level decision that should be driven by the type of vertical markets your company serves, the normal payment terms of your client base, and your company’s position on the topic. (Refer to “Taking Risks with Numbers: How Far Can You Go?” by Susan L. McGreevy & Kathryn I. Landrum in the September/October 2014 issue for more on this topic.)

Should front-end loading become a company standard, the minimum percent frontload should be a calculation on the schedule of values tool, to be reviewed for compliance and used as a metric for a PM’s performance. The goal of an effective schedule of values is to get paid for overhead and profit as quickly as possible, and is the single greatest impact a PM can have on his/her project cash flow.

Billing Strategies

Your company’s internal billing process should be well defined, communicated, reviewed, and measured. Let’s take a look at a sample billing process:

Repeat for Each Line Item on the Billing

1) Review the existing cost to date for labor, material, and other direct job costs

2) Identify additional costs of each direct job cost projected through the end of the month

3) Evaluate the percent complete

4) Mark up the billing item with the percent complete

Quality Check

1) Verify the total billing amount for all line items

2) Verify this total billing amount meets or exceeds the minimum established billing amount

3) Call or visit the client, review the bill, and get “pencil approval” prior to submission

To clarify this example, let’s discuss the minimum established billing amount. While some contractors take a “bill as much as you can” approach, this is not a measurable target. When discussing a minimum billing amount, targets should drive the positive revenue recognition that is the goal of a billing process.

For example, the minimum billing amount could be set at percent complete of the project plus 20% of cost. This approach verifies how effective the schedule of values is at driving positive cash flow.

What If You Don’t Get Paid?

If you don’t receive payment, there are a number of options, including leveraging your lien rights or filing on the payment bond. Be sure, however, that you thor­oughly understand the notifications requirements for either of these options to be effective.

Bring in your bonding agent and have an educational session with your project staff on the essentials of filing a bond claim. This could prevent the all-too-common late filing and loss of rights.

If you have disputed work, claims, or outstanding change orders, then negotiate a settlement if possible. If you are forced to go into arbitration or litigation, the chances of collecting the full amount of what you are owed dimin­ishes greatly, and the amount of time your project staff will spend preparing documentation for the case may diminish their capacity to manage profitable work.

Monitoring key indicators can enable early warnings of a cash flow issue. The development, implementation, and monitor­ing of effective schedule of value practices, billing strategies, and collections processes increase the chances of collecting the full revenue due, help drive down the timeline between submission of billing and receipt of payment, and place your company in a positive cash position earlier, thus reducing the cost of capital to perform work.

In addition, these processes establish levels of ownership and the ability to both measure and incentivize the right behaviors to keep cash flow positive for each project and the company as a whole.

By Stephane McShane

Stephane McShane works with construction related firms of all sizes to evaluate business practices and assist with management challenges and works at Maxim Consulting Group in Denver, CO. A previous author for CFMA Building Profits, Stephane has authored for ASA’s Contractor’s Compass and has presented at numerous engagements across the U.S. and Canada for ASA, ABC, NECA, SMACNA, numerous builders associations, and private contractors.

Source: maximconsulting.com


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